As a fellow business owner, it is very easy to get caught up in the day-to-day activities of running a company. You have fires to put out, products and services to launch, and existing customers to wine and dine. With all of this activity, you can forget what the value of a new client is to your business.
Terms like ROI, and the actual lifetime value of a customer, are terms that you should be familiar with, but they are often avoided by small business owners because they take a little bit of work to determine the actual figure. Let’s take a quick look at these 2 formulas, how to determine your number, and what this intelligence means for your business.
How to Calculate Your ROI
ROI is a very easy formula to determine. To calculate it, you take the gain of an investment, subtract the cost of the investment, and divide the total by the cost of the investment. Or:
ROI = (Gains from Investment – Cost of Investment)/Cost of Investment
So, for example, if you spent $1000 on a marketing initiative, or other business development expenditure, and received back $5000, you would see a 4x rate of return on the money that you spent during the initiative.
So, in a nutshell, you always want to be participating in activities that show a positive ROI or else you are losing money. Keep in mind that this is a relatively pure number and there can be other valuable things such as branding and other types of exposure that can actually enhance this number over time.
How to Calculate the Lifetime Value of a Customer
Another valuable formula every successful business owner should know is the average lifetime value of a customer. This number is critical, because it shows you exactly how much every new relationship is worth to your business. To determine this, you take:
(Average Value of a Sale) X (Number of Repeat Transactions) X (Average Retention Time in Months or Years for a Typical Customer)
To further illustrate, you could use the example of a dental patient who spends $250 every quarter for 3 years. The value of that customer would be:
$250 X 12 quarters X 3 years = $3000 in total revenue (or $1000 per year)
So from this data, you would gather the lifetime values of all of your customers, add them together and then divide by the number of customers to see what your average lifetime value of a relationship is.
SUM of All Customer Lifetime Values / Number of Customers = Average Lifetime Value of a Customer.
So Why Are These Formulas so Important?
For ROI
These formulas are key to really understanding your expenditures, and should be helpful in determining whether or not you continue certain activities within your business, especially on the marketing side.
I always tell our interns that the best way to think of ROI is to think about the following question:
“If you were sitting across the table from a person, and handed them a hundred-dollar bill; then they waited for 5 minutes and handed you $500 back, what would you do next?”
The answer is always “We would keep on handing them $100 bills.”
As long as you are getting back more than you are putting in, or seeing a positive ROI, it only makes sense to do so.
For Average Lifetime Value of a Customer
Along those same lines, understanding the average lifetime value of your customers is also a critical thing to know. It can go a long way towards helping to drive your acquisition strategy based on data.
Using the dental office example above, if you knew that the average person who became a client ended up staying with you for 3 years, and spending $3000 during that period, it may be worth providing a deep discount on the front end of the relationship to secure the business. After all, who wouldn’t offer a 1/2 price cleaning now, only to know that they will probably stay around for a while and become a profit center for your business.
As you can see, these numbers are critical to any healthy business, and software platforms like ReferMe IQ can make it easy to realize a positive ROI from your marketing efforts. You are dealing with a fixed cost, and can easily quantify the results. Referrals make the best and most loyal customers, so we have built our software to help your business ultimately see results.
